1. Field of the Invention
This invention relates to an automated system for tracking, reconciling and administering the values of life insurance policies in separate account, including stable value protected funds.
2. Discussion of the Background
For many years the majority of employee benefits have been funded through the purchase of stocks, mutual funds, corporate owned life insurance (COLI) and annuities. The value of these assets was generally provided on a quarterly or monthly basis, and the liabilities of these benefit plans have generally been made available on an annual or perhaps quarterly basis. Therefore, plan sponsors have had to wait six to twelve months for information about the current funded status of a benefit plan. In addition, changes in the tax code in the past few years have reduced benefits to highly compensated employees (HCE), that is, persons earning over $60,000 to $70,000 per year, as defined in the tax code.
In response to this decrease in benefits, companies are installing plans commonly known as Non-Qualified Deferred Compensation (NQDC) plans which offset some of the benefits being lost. By deferring money tax-free from employees and investing the deferred money in Elective Deferral Defined Benefit plans or Elective Deferral Defined Contribution plans, the NQDC plan helps employees regain lost benefits. Elective Deferral Benefit plans offer various fixed returns on the deferred salary (or other benefits) of an employee depending upon the amount of money deferred and the number of years the money is deferred. A deferral of a $1,000 will be used as an example. The plan promises a 7.5% return each year until the normal retirement age of 65. If the deferral is made at 64, then the maturity value is $1,075, and the balance is paid out in a lump sum. If desired, a participant may choose to retire early, at any age after turning 55. If a participant retires before age 65, the account balance promised at 65 is reduced by 7% for each year prior to age 65. If a participant leaves the company prior to attaining age 55, the participant is given the initial deferral plus a 5% interest credit for each year since the initial deferral. If a participant dies prior to retiring, the beneficiary receives the promised age 65 balance immediately.
Elective Deferral Defined Contribution plans work like investing in mutual funds. For example, when a deferral of $1,000 is made, the participant elects to invest his money in at least one of several funds sponsored by his employer. (Employers may offer several funds, e.g., a Bond fund, a Balanced fund, a fund which tracks the "Standard & Poor's 500" average minus a fixed percentage, etc.). At the time of deferral, the employee selects the Bond fund trading at $100/unit. The $1,000 is converted into 10 units based on the value of the fund on the day that the deferral is made. As the plan sponsor hold the liability for the employee/plan participant, the unit value is then adjusted daily to reflect the net value of the fund, plus any dividends or accruals paid. The value of the employee's investment is equal to the number of units multiplied by the unit value of the fund on the day of conversion. Therefore, if the per unit value of the Bond fund was $175, then the investment would be worth $1,750. Plan participants may also transfer deferred payments between Defined Contribution and Defined Benefit plans and between funds in the Defined Contribution plans.
However, the funds are hypothetical funds used to determine the return due to an employee and need not correspond to any real fund directly. For example, when a deferral is made to the bond fund, the plan sponsor may not actually choose to buy any funds relating to bonds, the plan sponsor may actually buy stocks, insurance policies or other annuities instead. The plan sponsor only promises to provide the return of the hypothetical fund (e.g., the rate of increase of the "Standard and Poor's 500.infin. minus some fixed percentage, the real value of the "Standard and Poor's 500" minus some fixed dollar amount, etc.). In fact, in cases where an asset group is overfunded (i.e., the assets exceed the liabilities), the excess assets may be transferred to other under-funded plans.
Furthermore, the regulations that apply to these plans restrict the manner in which these plans can be funded. In essence, companies may not directly fund the liabilities created by these plans, whereas the companies can directly fund their qualified plans. Instead of providing direct funding, a plan sponsor invests the unsecured deferrals in financial instruments of the plan sponsor's choosing (e.g., mutual funds, variable policy insurance policies, etc.) to cover the liability corresponding to each participant's investment choices. Because plan sponsors may not actually be investing in funds similar to the funds requested by the plan participants, plan sponsors need to have more immediate access to information regarding their plans. This enables the sponsor to cover its liabilities by reallocating its assets as participants reallocate their assets. The volume and timeliness of information is critical to a successful NQDC plan, and the traditional methods of providing information quarterly or annually have proven to be unacceptable. Since plan sponsors are receiving information and changes on a daily basis, the chances of a mismatch between the values of plan assets and liabilities have traditionally been high. Finally, participants were previously largely uninformed as to the value of their deferred money and benefits. Participants traditionally received a statement once a year, with no projections, and little information as to how the benefit was calculated. The dearth of information available to sponsors and participants has caused many companies to avoid the use of NQDC plans, thereby denying participants a chance at benefit restoration.
In addition to NQDC plans, corporate owned life insurance policies are an efficient funding mechanism for employee benefits. The nature of COLI allows corporations to invest money in mutual fund-type investments and ultimately receive the growth on the investment tax free. Typically, corporations have had to account for this investment on a mark-to-market basis. This means that the underlying investments were valued at market each year and therefore were subject to the volatility of the investment. This has caused some corporations to avoid COLI purchases, even though as a long-term investment it is highly advantageous for corporations.
One solution to the above problem is to invest in a new and useful investment division known as a Stable Value Protected Investment. This investment smoothes the return associated with the underlying investment. For example, over the long term, the Standard and Poor's 500 may be expected to increase by 10% annually. However, during the long term, the annual returns may be +15%, -2%, +8%, -5%, etc. In order to smooth the returns, the investments in a Stable Value Protected Investment would create returns of 10%, 6%, 8%, 6%, etc. Over the long-term, the Stable Value Protected Investment would perform equal to the underlying investment, less the fee for the Stable Value Protection, but would provide smoothing along the way.
Another use for the Stable Value Protected Investment is to reduce the impact of initial fees associated with the purchase of COLI. First year fees include Premium Tax, Deferred Acquisition Cost (DAC) Tax and Sales Loads. The assessment of these fees has the effect of decreasing the corporation's return on its investment for the first few years. A solution to the initial decrease is to increase the return on the Stable Value Protected Investment initially, then use the smoothing nature of the Stable Value Protection in future years to "pay back" the initial increase. For example, the targeted return calculated by the Stable Value Protection writer may be increased by 3% for the first year, 2% for the second year and 1% for the third year in order to reduce the perceived impact of the first year expenses on the cash value of the policy.
The Stable Value Protected funds provide an initial targeted return for the first period of an investment. Upon completion of the first period, the value of the fund, the "market value," is compared with the "calculated" value of the fund which is the "book value." The "calculated" value of the fund is calculated by multiplying the initial value of the fund by (1+targeted return), wherein the targeted return for the next period is calculated using the formula: EQU TR=(MV/BV).sup.(1/D) .times.(1+YTM)!-1,
where CR is the targeted return, MV is the market value of a fund, BV is the book value of a fund, D is the duration of a fund and YTM is the current yield to market. The purpose of this calculation is to insure that the book value and the market value move closer together over a period of time, namely the duration of a fund. The targeted return is reached by investing in a security whose value fluctuates daily and whose purpose is to make up the difference between the actual return and the targeted return.
The duration of a fund was first described by Frederick A. Macaulay in Some Theoretical Problems Suagested by the Movements of Interest Rates. Bond Yields, and Stock Prices in the United States Since 1866, published by the National Bureau of Economic Research in 1938 and incorporated herein by reference. The duration of security provides a measure of both the coupon of a bond and the term to maturity. Macaulay showed that duration was a more appropriate measure of the time element of a bond than term to maturity because it takes into account not only the ultimate recovery of capital at maturity, but also the size and timing of coupon payments that occur prior to final maturity. Duration is defined as the weighted average time to full recovery of principal and interest payments, using annual compounding. Duration (D) is defined as: ##EQU1## where t=the time period in which the coupon and/or principal payment occurs, C.sub.t =the interest and/or principal payment that occurs in period t and i=the market yield on the bond. The denominator in the equation for duration is the price of an issue as determined by the present value model, and the numerator is the present value of all cash flows weighted according to the length of time until receipt. This concept of duration is also disclosed in ANALYSIS AND MANAGEMENT OF BONDS, Chapter 18--PRINCIPLES OF BOND EVALUATION, by Frank K. Reilly which is incorporated herein by reference.
Using the concepts of duration and targeted return, the actual performance of the underlying securities in the fund is smoothed over time. The funds are created on a client-by-client basis, and therefore each client is subject to its own past performance when its targeted return is calculated. Consequently, each client will have a different targeted return.